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- [00:01]
A
Welcome to Top Traders Unplugged in markets. Success doesn't come from predicting what happens next. It comes from being prepared for what you can't predict. In each episode we go deep with some of the world's most thoughtful minds in investing, economics and beyond to understand how they think, how they prepare and how they decide and the experiences that shaped how they see the world. No noise, no no shortcuts, just real conversations to help you think better and invest with confidence.
- [00:36]
B
Welcome. Welcome back to this week's edition of the Systematic Investor series with Mark Recipczinski and I, Nils Castro Larsen, where each week we take the polls of the global markets through the lens of a rules based investor. Mark, we've got a pretty good, very solid actually lineup of topics that you kindly brought along. It'll be exciting to get into that and before we do so I'm always curious to, to hear a little bit about what's kind of come across your desk in terms of maybe other topics. We're not going to talk about anything you found interesting in the last few weeks. I've got a few observations, but I'd love to hear your. Whatever has caught your attention.
- [01:14]
C
Well, the, you know that I've talked to you in the past about being in a VUCA world. You know, it's your volatility, uncertainty, complexity and ambiguity. And we're living in a VUCA world now. And I think that's going to be what our discussion for the most part is that we're living in uncharted territories. And the question is how do you navigate that? Especially if you might be a quant investor, how do you navigate this kind of environment? So that's what's been the focus of my attention especially for the last couple of weeks.
- [01:53]
B
Okay. So I'll throw a few observations myself that, that I noticed, let's put it that way. But they're kind of on the same line in terms of uncharted territory when you mention that word. One thing that caught my attention was the new record set in the London Marathon. Less than two hours. I mean, I don't know if you've seen the guy running that and anyone who's close, but they run so fast. I mean literally they're like sprinting in, in my, in my world it's like sprinting and they do it for two hours. And I think even the guy who came second, he was like a world record, but he only got second place. Which is kind of, kind of crazy to, to think about, right?
- [02:41]
C
When you really think about it is this is that are there bounds by which we could behave, let's say physically, mentally. And it seems like we're constant, constantly challenging those outer bounds.
- [02:55]
B
Yeah. I mentioned to Jim last week when we were on. In my, in my. What's been on my radar. I mentioned actually that there was also now a record in terms of a robot now running a half marathon quicker than any human, which is also kind of uncharted territory.
- [03:11]
C
Right, right. I've seen those. The dancing robots and the robots chasing bores. I think there's a meme out there that we want to show robots is doing, being. Becoming more and more human.
- [03:26]
B
Yeah. The other thing that's somewhat uncharted was just a headline. No, no. You know, there's no focus specifically on, on the firm. And so maybe I shouldn't mention the firm. But there was, I think, the biggest redemption, at least that I'm aware of in the hedge fund world very recently, where there was a client who redeemed $6 billion from a hedge fund. And the name will remain unmentioned, but I mean, that's a massive redemption to receive on your facts one morning, I imagine.
- [04:00]
C
Well, that's. I think that as investors, over time, and we'll say, over the time that I've been working in the investment world, you'll say that investors have become more, more and more sophisticated and as their sophistication has increased, they demand more from the managers that they invest with. And so, you know, I, I think that there's competition across firms, but then there's also the competition of just meeting the expectations of investors. And they're. It's pretty high because they're fairly sophisticated themselves.
- [04:39]
B
Yeah, no, no, absolutely. And of course, another thing that did hit my radar yesterday was, I think, the last press conference from Jerome Powell as Fed chair, but the fact that he's staying on the board, I don't know if that's completely uncharted, if it's happened before, but kind of interesting. And also the other thing that was a little bit uncharted was it was an 84 vote, which I think is the first time since October 1992. So. So quite a few things happening. But, you know, he was the fed chair from February 2018 to May 2026. And for sure, it's been an interesting time to have to navigate the, the interest rate levels in, in the world.
- [05:31]
C
It is a very interesting precedent because usually if you're done being chairman, you might still have extended time on your appointment, but you don't go back to being just A member. So this is somewhat unprecedented. Most people would sort of say I should just resign now. I think that while everyone focuses on Paul, and this won't be the focus of our discussion today, probably my discussion with many smart investors has been what kind of chairman warsh will we have? Are you going to have the warsh that's, you know, sort of following a Trump lead of lowering interest rates, or are we going to have the war of the past who has been somewhat negative about quantitative easing and thinks that the Fed balance sheet should be shrunk? That makes a huge difference on what kind of worse you're going to get and it makes a huge difference on how markets will behave. If we really have a Fed chairman who believes that the balance sheet is too large and is going to have to be shrunk.
- [06:47]
B
Yeah, no, absolutely. I guess the final thing I noticed that I guess you could also say is in uncharted territory was the fact that the UAE left opec. That's kind of an interesting development as well because they're not a small member, so to speak. So does that mean more, even more volatility in that sector? I don't know.
- [07:17]
C
But yeah, that again is a very dynamic environment. They do have a pipeline that avoids the Straits of Horboos. It can handle up to, you know, Some people say 2 million barrels a day and it seems that that has been reported to be a little high. It might be about, you know, 1.5 million barrels, but that's a, that's a big number. And so they're going to say we're going to push out as much oil as we can while this crisis is going on. Because we can't. Because we can't.
- [07:53]
B
Yeah, exactly. I think that that's what the speculation is, that if they're not a member they can even put out more. However, they still need to get it out physically, so to speak. So if the limitation is the pipeline, then I'm not too sure how much more they can pump. But I'm not an oil expert, so I will leave it with that. Speaking of oil, Mark, let's get into some trend following update. You and I are speaking on the last trading day of April and if all goes well for the next eight or ten hours or so, it looks like it's a pretty good month for Trend followers and CTAs. In fact, and I haven't checked this, I would not be surprised if the Soc Gen Trend index makes a new all time high. I would not be surprised if a lot of CTAs are going to end the month at a new all time high. So among all this turbulence, among all this uncertainty, even though it also is a very strong month, as we will learn in a second for equities, these strategies are coming out pretty strong after of course, March, which was, you know, a correction month because of the surprise, quote unquote, surprise attack in the Middle East. But I guess it just reminds me that sometimes it's, you know, people want to pin down the strategy as something like, oh, it's a crisis alpha or it only makes money when everything else goes pear shaped. But you know, we should stop and also just take note of the fact that even in one of the strongest equity months we've had for a long, long time, actually it's also pretty strong CTA month and of course performance, which I, at least from my vantage point, looks pretty broad based in terms of sector participation, despite the fact that we can't get around that the energy sector is most likely going to be dominant. And of course there are some complete outliers in terms of people with massive oil exposure who are up significantly this year. But as an industry it looks pretty good. What have your observations been so far?
- [10:17]
C
Well, we've often talked about the Goldilocks conditions for trend following in the sense is that you can't have it too short, can't be too long. But what we do find from all the research we have is that the more that you have a length of some type of cris, the longer the length on the crisis, the time that we're in crisis, the better you'll be for a trend follower. So let's take for example the pandemic in March 2020. You know, huge market move, huge correction. A lot of CTAs were negatively affected by that because we had that huge dip and then it came right back in less than a month's time. So from the Goldilocks effect, there was a crisis, but it really didn't have enough time to sort of show up for longer term trends. Not unless you were a trend follower who looked through certain events. This is now playing out as we move through time. This crisis lasts longer and longer. Then it allows more for the price behavior to be displayed in trends so that the trend follower could take advantage of it.
- [11:37]
B
Yeah, what's interesting to me about it is that yes, March was certainly a month where we had to trim equity exposure because of the reversals. It probably for some managers meant getting out more or less completely. It also meant maybe for some getting slightly short, but also for the many kind of longer term trend followers, they remained long. There's a couple of things that I noticed. One is that there's been a flurry of predictions, let's call it that, by the investment banks. And I have to say, I mean Goldman Sachs has been quoted a lot about this and that is about these, you know, all CTAs are going to buy $86 billion worth of equity exposure in the next week or they're going to sell. I mean all this speculation about what managers are going to do when I, when I see them come out and maybe they're not the ones putting them on in the media but they are producing the, these observations in the first place for the media to distribute. I guess it kind of boggles me a little bit that there is so much attention on it and often it's not very accurate. At least when I look at how we are changing our exposures and positioning. So I don't think it's very useful information but it certainly is something that has caught the attention of, of many. What has caught my attention is more actually the changes within I think the CTA space. And that's to do with fixed income. It looks to me like fixed income positioning did change in March to the short side and that we've kind of been building on that and with you know, recent expectations to an ongoing conflict, you know, inflationary pressures are mounting. Maybe we'll talk about that later as well. But I think that's been the big change maybe to some extent also the dollar exposure might have changed as well. But, but certainly fixed income and fixed income has been difficult for trend followers for quite a while. You know, long, short exposure, changing every, every sort of six, eight weeks. So not an easy sector. But we'll see if this one is going to stick around for a little bit in terms of more downwards pressure on fixed income prices and upwards pressure on, on interest rates.
- [14:07]
C
Now Niels, this whole issue is, is very interesting because I guess I said one of the problems with aging is that you remember from things from the past that in your career and I will sort, you know, prime brokers, brokers in general have for decades been trying to reverse engineer trend following programs in an effort to sort of say can I understand what they're doing or when they're going to enter the market or when they're going to exit. So this is nothing new. What is new and I think that is important is that people are now using more AI to help them on this reverse engineering in particular. There's been some recent work. It was an interesting paper called Mimicking Finance. And what they did is they said that it took a lot of portfolio managers and they said well I'm going to sort of create sort of agents, AI agents to try to replicate their behavior. And what they find out is that oftentimes they could get about 70% plus of the behavior of managers by using some AI agents to describe, you know, training strategy and behavior. What they find is that even though that they could replicate fairly close, their performance is generally under the best managers. And what they find is that the best managers are fairly dynamic or that they have, they have rules or behavior that is hard to mimic. Okay, so you can mimic the average, but you're generally you're going to underperform, but you can't mimic the best managers.
- [15:59]
B
Well, the last line kind of goes to a point that I respectfully made to one of Andrew's colleagues who were posting about their returns and comparison that to I would say not very that super relevant, but I'm biased. Let's, let's remember that. But not the best indices that I could think of. If you want to compare yourself to that and some Morningstar type trend following systematic. It's not really the indices that I would compare to and also, but anyway, I mean the whole thing about replication, I wonder do you really need an AI nowadays to do that? If you can just look up the replicators positions in the ETF space every single day, do you really need an AI for that? I know why they're trying to do it, but it's kind of funny. But I mean, wow.
- [16:58]
C
Now part of that is that you actually bring a good point and this has been another ongoing issue is that do we need the added complexity? And you actually had this in one of your past ttus is this is that you know what happens when we add more complexity to bottles is do we really get an advantage? So with hedge fund replication, the idea is that since AI agents can actually sort of be used to include non linearities, include other behaviors, can you improve it? The question is that how do you compare that against hedge fund replication or replication strategies that are simpler in general? Because I've worked in this area a little bit in terms of research, the hard part for replication is capturing the non linearities associated with trend following behavior. And what do we mean by nonlinearities? This is that if I'm looking at some replicating a moving average strategy that's I'm not saying it's easy, but it's relatively easy. The hard Part is that when you think about a lot of managers use breakout systems, a breakout system is somewhat nonlinear in the sense is that you're dormant until you see a move in the market and then when that move reaches some threshold then you'll kick in with positions somewhat nonlinear. The non linearity is the hard part in hedge fund and we'll call it trend following replication.
- [18:44]
B
Yeah, I mean that brings up a good point. Not that it was one of the points I had expected to, to discuss with you today but I mean as you know I voiced my concern about the narrative about replication being simpler than what we do. On the other hand, I completely agree with you that you know, in my opinion it's not quite the same that they capture. But I mean it is interesting what what you mentioned because I don't know that many CTA of the larger ones still use breakout. Actually I think they, I think we as an industry have moved towards more continuous signaling now. And the reason I say that is I see some of these, you know, they're not small but they're smaller managers where I do think they use sort of breakout type style and then they also use some very different risk management techniques. Much more static position sizing. Some of them are shooting it definitely out of the park at the moment this year way above anything that replication will capture. On the other hand, we obviously have to recognize that replication in the relatively short period it's been around has kept up overall performance wise and, and in some cases also outperform the indices, but not necessarily. And that was the point I was making to one of Andrew's colleagues. Not all. It certainly hasn't outperformed some of the best managers and obviously I can just look at our own, you know, equivalent funds and there was no outperformance. In fact there was much more downside volatility and drawdown in the replicator compared to. So I agree with you. It, I think for me what the, what the conversation and I don't have the skills or the time to, to kind of dig deep enough into this. But I think what the conversation lacks is that we kind of just conclude that just because the performance looks the same it must be the same. But this is where I just don't think that is true. And even with a correlation of 0.75, 0.8, I still think that that doesn't prove the point about oh yeah, we can just easily replicate, you know, these managers and we do it in a more efficient way. So we will always outperform over time. I just I just, I find it so difficult to, to buy into that narrative.
- [21:23]
C
Well, well two important points is is that when I use the word breakout system is this, is that we'll probably sort of say no one's going to walk into the in an office of an investor and say I'm using a breakout system is this, is that also to say that that's more of a catch all for threshold based or trigger based signaling. So in the instead of having a continuous signal there may be some threshold by which you'll take action and then a threshold where you take off action. But in a replication issue this is you could have a pretty high correlation but you could still have a negative beta relative to the managers set of managers you're trying to replicate. So correlation may not be the best guide for a replication strategy and that's what you know and going back to basics is that it's that alpha component that is the intangible that's not being picked up by some factors which is you can't replicate and is also what people will be paying a premium for in terms of, you know, someone that will. They'll be willing to give money, they're willing to pay fees and pay the incentive fee.
- [22:42]
B
Yeah, absolutely. Mark, I'm going to give a quick trend following update. As I mentioned, it's a strong month so far in April and my trend barometer yesterday closed at 55 so that's pretty solid and I think that reflects well the performance we're seeing at the moment as of Tuesday 28th April. And by the way, I think yesterday was another positive day. Maybe not a huge day but a big, but a positive day. We have The B top 50 index up 1.84% in April, up 9.46% so far for the month. Sorry. For the year. SOC gen ct index up 2.31% in April, up 9.92% for the year. Soc gen trend very similar up 2.45% for April, up 9.71% for the year and the short term traders index up 56 basis points and up about 5% so far this year. The British Alternatives which is a flat fee trend following index of fewer managers up 4% as far as I can tell in April up 12.39% so far this year. MSCI World as I mentioned it's have it's a great equity month up 8.35% as of last night, up 4.59 for the year. The S&P US Aggregate Bond Index pretty flat in April and Pretty flat so far the year to date, only a few basis points and the S P500 total return up a whopping 9.37% in April and up 4.63 so far this year. All right, Mark, we are now at a point where we're going to talk about your very long list of topics and I'm completely at your mercy and, and, and where we're going to go with this. But it is somewhat geopolitical in its flavor as far as I can tell. So why don't you take over and tell us what we're going to learn about today?
- [24:45]
C
Well, it's geopolitical in its flavor only because geopolitical events is what has been driving the markets. And obviously we just talked about the performance of trend following. We see that as this geopolitical event in the Middle east as it extends, then what we're going to see is there's the chance that dislocations are going to have stronger effects, longer effects and is then going to be displayed out and prices. So perfect example is this is that we had a shock to oil prices. There are some reversals at different times based on comments that were made, but surprisingly this is that the markets is stayed higher. If you were, if you got long early in March, is that even though you're facing more volatility, you've done reasonably well. The other thing that's important about this particular event is that it is a supply shock. And we'll sort of say that the global economy has difficulty with supply shocks over demand shocks. And the reason why is that with a demand shock, central banks are pretty, the playbook is pretty well scripted. As I said, we lower interest rates, boost demand. We could then be able to reverse the problem. It could be in the fiscal side, certainly on the central bank, monetary side. But if you have a supply shock, what do you do about that? It becomes a little bit more difficult to deal with because do you accommodate a supply shock which would then add to inflation. I know we just had the Eurozone inflation, it's coming up at 3%. We'll say US inflation. You know, I'll say a new Fed chairman might have a different way to view it. You know, some trimmed mean inflation, but we're seeing this is that it's persistent above 2%. So you have a problem that the central bank doesn't know what to do or central banks don't know what to do because of what we see as a supply shock. So that gives us into more of a 70s kind of world and if you have a 70s type world then you could be able to have extended price trends across many different markets. The other thing we forget about this geopolitical, it's having an impact across all commodity markets, some of which we haven't seen yet. Take for example fertilizer. Said a lot of fertilizer comes out of the Middle East. So straits are moose is closed. You know, fertilizer is not available for plantings. I think what we're seeing is, is that there's shortages of propane, butane and other refined products, especially in Asia. But which means is that you know, some restaurants are closing down, other businesses are closing down. So that's going to have real effects on equity markets and in the macro markets. So we're going to see that this is going to have long ranges of effect. Now the interesting part is as I always go back to Sherlock Holmes and remember the story where he said that the dog that didn't bark. So the real question comes in with all of the shock that we've seen. Surprisingly equity markets have held in. Well, we've seen some movement on fixed income, we've seen the behavior in energy, but it seems as though that there has not been the proper discounting of this large event. And what I mean by that, when you ever say the market is not discounting the markets, it means that you have an opinion. But you know, Niels, I'll ask you is, is that if I told you you're going to have this kind of energy shock and then said tell me what you would have predicted would happen to equity markets, what would you tell me?
- [28:55]
B
I think it's often the case that people think that okay, higher inflation means higher interest rates, means lower equity prices. But as far as I know, slash remember I think that actually plays out a little bit later. Meaning the initial inflation period is not necessarily bad for equity right now we'll
- [29:18]
C
sort of say that the one problem or the one issue I come back to is this, that we'll call it the World War I problem. And you know, what do you think happened? This is after the Archduke was shot and there was some mobilization. But, but we didn't have, we didn't start all the all out war yet. What do you think happened to you know, equity or how, what was the behavior of equity markets before September 1914?
- [29:52]
B
I love it when you ask what do you think happens? Because you know, I have probably no clue.
- [29:57]
C
So but you know, we'll take you as a representative, you know, intelligent investor and, and I think that when you sort of say that. Yeah, I don't really have a clue. And, but you'd sort of say, well it must have been the equity markets are forward thinking, they must have discounted, you know, the, the chance of war. And, and the answer is it, it didn't. You know, they are completely surprised by the war. And you know, I think that there's issues where you could say that are we going to be surprised in equity markets by what's happening in the Middle east or have we not discounted? Another, you know, sort of fact that it shows gives me some pause this is that if you look at the VIX index, VIX index has actually fallen. You look at some of the uncertainty indices, they're still fairly high. Some of them haven't come out for the last month because they're only produced monthly. But the, but the data suggests is that we have relatively high uncertainty. But it seems to have peaked. The daily uncertainty indices have been very volatile. But you know, VIX volatility or stock volatility is actually declined over the last month. It's probably a little bit higher than the median but we'll say it's certainly not elevated. And if you said that they were going to have a war in the Middle east like this again, I think that you would say if you're, if I asked you as an everyman, what would you think would happen to volatility?
- [31:36]
B
Well, the thing is we get, we get. I mean I think the answer is, you know, self evident, but I think that, I think also in a sense, unfortunately it reflects that we are kind of getting numb to all of these messages coming out left, right and center even though some of them are a horrible. That's the.
- [31:55]
C
Yeah, right. And, and even when you get yes, we're almost like numb to the information we come. But even if you get inundated with all of this information, it would seem as though that, and we'll call this the Inundated with information with conflicting signals is a, is a form of ambiguity. Okay? It's ambiguous what is going on. And in an, in an ambiguous world, a world with high uncertainty, the normal expected behavior which is going to be good for trend following is that everyone is going to slow down with their decision making. If you're going to make a decision and you had better certainty you would act fast or you would be decisive. When you feel that there's more ambiguity about what signals you're receiving, if you see that there's greater uncertainty, this is it. You might dollar cost average, you might hold back your Behavior, you might wait before you take action. And all of that behavior should lead to more price trends. That is what we're seeing. And then we're, and we're seeing that. That's one of the reasons why trend following is, is, is doing well.
- [33:15]
B
You know what's fascinating about that, and I think this is something at least I hear from people, maybe it's something you want to bring up later. So apologize if I skip the queue here a little bit. But we're now talking a lot about AI and all of that, but leave that aside for a second. Clearly one of the things that has changed in our careers, let's put it that way, is the introduction of the Internet. And with the Internet and what followed was this information flow that became instant. We all knew what was going on at the same time. And I certainly remember from decades ago talking to people about it where they were kind of questioning, well, how is trend following going to cope with the fact that now we all have the information at the same time. And so what's interesting about what you're mentioning is that information, even though there is a limit to how quick it can become in terms of distribution, let's just say that it's pretty much instantly distributed. Now you would, you would kind of think, well, that must mean that shorter term time frame, shorter term models should be doing better, they can navigate this quicker. But as you rightly mentioned, what's been clear not just this year, but generally in the last many years, is that it's the opposite. It's actually the slower systems, the slower models that are better at navigating the environment. That's kind of interesting and, and a bit counterintuitive in my opinion.
- [34:56]
C
Well, I think you're touching on it. One of the fundamental issues of how markets behave over the last few decades is, is that then there's information reaction or so. So information is now more readily available than before, which means is that the markets should become more efficient because you get the information right away, you can act on it. But the real issue in where you make money is that what is your ability to process that information? Are. Our ability to gain information is better than ever in the past, but our ability to process that information may not have improved. And so consequently is that there could be more uncertainty that leads to behavior or the leads to behavior that leads to trends that last longer than expected. Now, can I form a direct hypothesis about this? Can I be able to find a testable. Yeah, that's a little bit harder. But we will sort of say that the people who are very high frequency traders or those who react immediately to new information, you know, some they have an edge, but those that actually sort of say that allow for the human behavior, that processing is still difficult also have an edge. And those are for trends that are longer, not shorter.
- [36:32]
B
Yeah. By the way, the whole supply shock and where you said it's actually harder for the economy to deal with that, is that part of this quote unquote newer inelastic market hypothesis that people are talking about? Is that part of the same argument?
- [36:47]
C
Inelastic is not so much has to do with the behavior and flow of markets. I think that the, the supply shock problem means, is that governments who can actually arrest trends don't know how to deal with it. When you think about it, is that the worst fear of a trend follower is that the trends start to occur and then government policy comes in and arrests the trends or tries to reverse it. So let's say that you have market is moving into a recession. If we move into recession, you'll see equity markets decline. You're going to have a reaction in commodity prices. You're going to have a reaction to fixed income market. Well, so you start to see that market behavior is sending signals that'll tell us what are trends that are associated with recession. Well, what is the worst thing that you could, you could see happen if you're a trend follower is that the government comes in and then says well if the market is declined, I'm going to try to reverse that flow. So if the equity markets are declining, I'm going to do something that's going to reverse that that flow. So then the trend trends are going to reverse. You're going to actually sort of be hit with losses. You might then see a drawdown. The supply shock environment. What is the proper response by government? It's not clear. So that means that prices are going to be primal. Prices are still going to be driven by market behavior, not by the behavior of governments.
- [38:36]
B
Yeah, although just, and this is a sample of one. So people should be incredibly skeptical about it. But I do remember when they last time really intervened was in March of 2020. Not the government, but certainly, you know, the Fed did, probably by the invitation of the government. And, and you're right, that certainly led to some reversals and some trends that changed direction. But it also led to one of the strongest periods for trend following subsequently because it turned out to be incredibly inflationary afterwards. So yeah, you're right. I mean we don't want people to influence markets or Trends for sure. But I mean, sometimes it can actually, because they're reflexive, I guess, is that they, it can, it can lead to some opportunity.
- [39:26]
C
Well, we'll sort of say that. A corollary to what I'm saying is, is that, okay, let's go back to the pandemic which was say a government induced supply shock. We'll sort of say, not the pandemic itself, but the response. Okay, well then, then, then the government said like, well, now we're going to have, we induce the supply shock. But now what we've got to do is we've got to do something to offset the supply shock that we generated. So what we're going to do is increase fiscal spending, we're going to keep interest rates extremely low, we're going to flood the market with liquidity. And then lo and behold, what do you think happened? You actually got inflation. Okay, so their response to this supply shock was to say, how do I offset the supply shock? But by offsetting the supply shock, then they actually created a bigger problem which actually led to inflation, which then led to, you know, advantages for trend followers.
- [40:32]
B
Indeed, indeed. Well, talking, talk about trend followers, I noticed in your, in your notes that you have a point called my current research on difference of hedge fund strategy sensitive to risk volatility shocks. Right, but there are exceptions. So is that what we're going to hit now?
- [40:48]
C
Let's talk about this because, and I think that it's always good to put in a discussion of trend following or in the context of how it fits within all other hedge fund strategies, because I think that when we look at the institutional investor, he doesn't think in terms of am I going to choose trend following? They're going to say how do I choose trend following vis a vis all the other types of hedge fund strategies that might offer diversification, which one is better? So you're not competing against other trend followers, you're competing against all other hedge fund strategies. So one of the things I wanted to look at is that when you think about it is that we've looked at how hedge fund strategies beta and we can be able to classify them. And what we've the standard argument is that the beta for trend following is close to zero. So it's a very low number. Other hedge fund strategies still have positive beta. So he said like, okay, that if you really want to have strong diversifier by managed futures, okay, what you find out is that some of the other strategies have higher alpha. And this is by just looking at a simple regression of Looking at systematic risk and measuring alpha over time is that they might have significant positive alpha. If you look at trend following, not so much the case, you're going to find out that the alpha is, is close to zero. So you get this diversification benefit on your beta side but you're not getting a lot of alpha so you have a trade off. I said well let's take a look at how different hedge fund strategies, how they behave with respect to risk and we'll call it risk regimes and then risk shocks. So what do we mean by risk? So we can look at the VIX index is a perfect example as risk and the VIX index is different than the systematic risk that we see versus the stock market. So we ran and found out and looked across all hedge fund strategies and said well how sensitive are you to sort of the risk regime? And what we find out is actually we standardize what the VIX index this is that if there's a low risk regime or hedge funds generally do better. So low risk they do well. So when we see high risk and serve. Sorry Niels, I'm going to have to ask you as my everyman, what do you think hedge fund strategies how their excess returns behave during high risk environments?
- [43:57]
B
Oh, I'm sure they're not as great as trend following.
- [44:02]
C
Exactly. So, so what you find out is that high risk regimes this is that there is a negative well the coefficient is, is negative which tells you is is that you know, high volatility. A lot of hedge fund strategies don't really do that well. So even though they may market themselves is that we have manager skills and our skill is that we can be able to risk manage better than other types of managers. That's surprisingly they have a negative coefficient to the risk regime. Now when you look at managed futures they're actually insensitive to the risk regime. So whether it's high risk or low risk, that coefficient is not significant. So it tells us that a trend followers is not dependent or is not affected by the by the risk regime, which is very interesting. So if you're really worried about risk in your portfolio, meaning volatility as measured by the vix, this is that managed futures will be a better choice than many of these other strategies that may generate alpha, but that alpha is actually dissipated once you take into account how the risk regime you have. So in particular then we looked at what is the alpha for these different hedge strategies in different risk regimes by partitioning the VIX into low, medium and high and we'll say that if you're looking at what happens to alpha in a high risk regime, it actually turns negative. So if you have alpha and you sort of say like, hey, I'm a good manager and I show skill in a low volatility environment, in a high voluntary volatility environment, I don't show it. On the other hand, managed futures, again it's a sort of invariant or independent of the risk regime. And then finally what we did is that we said let's look at this in terms of risk shocks and in particular it's a, what is a risk shock, which would be the change in the VIX index because it's maybe not the risk regime, but we'll say it's not the regime. It's the fact of whether I have a big shock to volatility, either positive or negative, that matters. And again, as I said, most hedge fund strategies don't really do well with positive risk shocks. On the other hand, managed futures, again seems to be invariant to wrist shocks. So in some sense is that, you know, you got the advantage of a low, low beta, but more importantly is, is that you're not sensitive to the type of risk environment in terms of regime or shock where other hedge fund strategies that might purport that they're offering diversification just don't do it or don't offer that advantage.
- [47:19]
B
It's interesting, Mark. The reason, I guess I got your surprise question right is because we looked at this in a slightly different way about six months ago and we published and when I say we, I mean done and, and, and we published a couple of, of reports about this studies where we, I think for the first time I haven't seen anything published like this before where we looked at all the alternative investment strategies we could get our data on. I think there's like 14 or 16 of them. And then we went back to the same time as when the trend index started in the year 2000 and we looked at all this but not necessarily in specific VIX environments. So I'd certainly love to see your, your study on that. But I just wanted to mention that we just last week updated this study with more data and for those who want to receive not a, not necessarily specifically about done but about trend and, and high volatility trend in particular, I'm going to publish that as part, on a regular basis as part of my, my Sunday email updates and people can subscribe to that on toptraders unplugged.com forward/ Sunday. So just if people want to see this, there is definitely Something that I can share publicly on that. But it's slightly different way of attacking, of, of attacking the same kind of question. How do these strategies actually perform and which are the most valuable alternative investment strategy? Because I think that's, there's a lot of confusion about that.
- [48:57]
C
Right. And this doesn't dissipate, you know, the conversations and all of the research and work about, you know, crisis alphas. So, so, but, but we want to try to, and I think as a, as a group we're going to talk about trend following and, and manage futures. We want to get beyond, you know, just the crisis alpha story.
- [49:20]
B
Yeah.
- [49:20]
C
We want to try to sort of say, are there other ways that we can be able to look at data in a very systematic way to be able to sort of say, is there something unique about managed futures versus other hedge fund strategies? And so you say like, well, what are people most focus in on and where do they really worry about? You'd sort of say, yeah, they're worried about what's my overall portfolio beta or not. But I think in reality if say, like, if volatility is high or volatility is increasing, I want to find strategies that actually will protect me against a high volatility regime or do better in a perfect world. Reality is it's hard to find strategies and that doesn't mean that you won't find individual managers who do well. But it's hard to find hedge fund strategies that do well in a positive risk shock or a high volatility regime. But you do have some exceptions, and that's managed futures. You also have global macro does similar. But then you could say global macro and trend following are also similar strategy ones, systematic ones, a discretionary representation of a large set of markets. So, but you could sort of say there are unique characteristics that are associated with managed futures that you don't find with other strategies that you say that is offer benefit beyond just the fact that it's a low beta strategy.
- [51:05]
B
Yeah. Is this part of your kind of putting context to different types of analysis, storytelling versus narrative?
- [51:13]
C
Is this the, this is the context issue with something that spent a lot of time with. Because when you think about what we do, when we sell strategies or actually develop strategies, we always talk about context or narrative. And in some sense I'll talk about two quotes to set this up. And this is from Daniel Kahneman. So you know, Daniel came in, the Nobel Prize winners or, you know, behavioral, you know, finance guy. But he said no one ever made a decision because of a number. They need a story. And then he also said the confidence that individuals have in their beliefs depends mostly on the quality of the story they can tell about what they see, even if they see little. So in some sense this is at. What's one of the constant challenges for managed futures is this is that if you say okay, what do you do? And I'm making this overly simple, I follow trends and this is what does that mean? Prices go up, I'm a buyer, prices go down on the seller. So that's it. What do you think about the market? Tell me about what you think about what's going in the Middle East. I really don't have an opinion. Oil prices are going up, I'm a buyer. If they're going down, I'm a seller. And I think that that is a classic conversation that you would have with a trend follower. Yet in reality the investor is saying it's like gee, you know, I want to hear the story, give me the story. Then the next global macro manager or some other manager comes in and he said well let me tell you about what's going on in Iran. Let me tell you about the pipeline that's going from the uae. Let me tell you about the number of ships and how we look at geopositioning to find out what the ship traffic would look like. And I said like wow, that's a very smart manager. But. And it's because he gives context or gives a story or narrative. Now I'm giving one example of story and narrative as persuasion. But I think that context matters for our trend following behavior. The question is how do we add context in our modeling? And we'll start out with what we started our conversation. We talked about geopolitical risk and then we said about how this plays out in and price shocks in it and how you know, if markets dislocations extended for a longer time it's better for trend following that provides context. Can we be able to use different tools to provide context to add value to our models? And that's an ongoing issue of, of how do you best use AI. And this is where we're actually seeing more AI being used in two areas. One is in natural language processing to come up with sentiment measures. Okay, I think that that's becoming a very interesting area of research for quantitative analysts and then for large language models, LLMs because how do we process a lot of information, some of which is non numerical in a way that we can then be able to convert into signals. Now perfect example is that what we find is that for natural language processing we could take earnings calls and we could be able to use what is called a bag of words and then be able to try to figure out the sentiment that's occurring in the marketplace. This is proving to be very profitable and being used by a lot of firms. Question is, how do we use that for a trend following model? And I'll sort of say that the jury is still out. Not that there has been negative work, but the work hasn't been done yet.
- [55:39]
B
Yeah, no, it is interesting. I mean it always in my mind comes back to this thing that a lot of this sentiment and so on and so forth should all be reflected in the price. And the price is the only truth that we have. And, and I'm not suggesting that things won't change in the future, but I'm also noticing that for so many decades, with so many different changes in the world, in the technology and so on and so forth, those managers who've just stuck with using price has actually done very well. Even though there is a difference. For sure there is. You know, now we hear something about economic trend. Well, that's maybe giving context to, in another way. Right. But, but I just don't see it necessarily as being better. And, and, and I'm, I'm, I'm happy to see that classical trend following using price is, is still very potent right now.
- [56:45]
C
This is, again, this is ongoing research and I think it's important to try to, to test different hypotheses. You may come to the conclusion it doesn't add value, but that doesn't mean we shouldn't try to look at this. Now what we found is that in just some of the research that I've been looking at is that for example, is that for a lot of LLMs they'll use multiple agents so that you come up with an agent. Agent has a very specific task in, in a, in a process. So what they find is, is that if you have an, a model that has an agent, one is following technical signals, another one that's looking at fundamentals, another one is looking at sentiment. And then you sort of ensemble all of those agent behaviors, you actually get better sharp ratios than if you use a coarse model which only uses one agent. So what would be the analog is that you could have a trend following agent in some type of AI model, but then you also have other agents that do other things that are coming up with other forecasts and you blend them together. Can you actually do better? Now, is there a real life analog for this? Is that we do know that when you look within, we interchangeably use the word trend following versus managed futures. We do know that finding a pure trend following manager, there are fewer of those and more of them try to mix and match, you know, sort of other types of strategies within that that may be changing. Again, they may go back to pure trend following. But when you think about a manager that uses a number of different strategies, he's acting like a multi agent LLM.
- [58:49]
B
Yeah. I mean again it's, it's interesting and, and I hear this narrative that using more things is potentially better. I just think it's an easy narrative. Right, because it could also be much more confusing. I mean you could have strong GDP data but the markets could still be going down and so on and so forth. So I get it and I know we're heading in the way where people will innovate and they will use things and combine things and that's great. I just personally think that it's also great to see that just sticking with kind of a more narrow set of information and in this case where it all started, namely price, seems to at least continue to work well for now. And, and we'll see. But I also find it, I think your other point about, you know, there aren't that many pure trend followers left and, and, and so that's also maybe just part of the evolution that maybe there will be even fewer of us left in, in five years time because people will have added more things to their, to their strategies. I don't know, time will tell.
- [60:02]
C
And, and that gets down to one of the class when you pick, you know, strategies, hedge fund strategies, should you want to have a pure strategy and then be able to find another pure strategy of someone who's doing someone else and then you as the investor, you could blend whatever you want. So for example, and I'm not saying that people would do this is that I have a manager over here that, that is a, we'll call it a carry expert. You know, it's, he's Mr. Cary in terms of all a different form. And then I have another manager or that I'm looking at that's a trend follower. Now would you prefer to have a manager, a single manager who does both together in the same, in the same fund or would you prefer that they say you purely follow trends, the next person follow Carrie and then I as the investor will figure out what the weights that I want to have for my portfolio, and that's an ongoing issue of finance, is that should you buy it bundled or should you buy the component Parts.
- [61:14]
B
Yeah, yeah. And we see that as well with portable alpha.
- [61:18]
C
Right.
- [61:18]
B
I mean everybody can create, you know, more or less everybody can create their own portable alpha product. But of course there's been a huge market where they successfully have, you know, bundled it together and it maybe it's easier sometimes to give the investors what they need in a package that they want. And maybe that's the, that's the answer.
- [61:39]
C
Right. And that's sort of say that the, in driving, in very simple terms this is that the behavior of multistrats is in substance they're saying this is that we have maybe you know, hundreds of pods. What they're saying is that all those pods are supposed to be orthogonal. They're all supposed to have slightly different strategy. They say like, well you could go find, you know, managers who are like a given pod. But what we're going to do our value added is that we could bundle all of those pods together in a better portfolio than you could. We could then react in from a risk management perspective faster than you could. So say this is our value added statement. And so will say Wall street is constantly focused at trying to figure out how to bundle or debundle different risk premia or different products in an effort to serve clients. And the investor is constantly having to sort of say do I do the bundling or do I let someone else do the bundling? And this is going to be the age old problem.
- [62:49]
B
Wall street has always been good at bundling. Do you remember when they bundled together really bad loans and it became a not so great solution for the investors?
- [62:59]
C
Yes, there's, there's, there's good bundling and bad bundling and sometimes we, we may not know what is good or bad bundling until after the fact.
- [63:09]
B
That is, that is very true. Anyways Mark, I know you have a hard stop today, so should we leave it here? Is there anything else you want to just mention?
- [63:21]
C
Well, the, the one that I asked is that I'm going to come back to is that there's been some interesting research on, we'll call it buy modality and deep momentum. And what they, you know, and if you look at momentum uses it you actually look at, you know, separating winners for, you know, look at winners, past winners or past losers. You know, that also goes on for trend following and it's cross sectionally. But what they find out that within the set of past winners or past losers is that there's a lot of, you know, quote unquote noise or that you'll, but you'll have some past winners that continue to win, which is what you'd expect in momentum. But then you have some past winners that lose really bad and they're and they use that as an explanation for why there could be momentum crashes. And I think that this is another area of research is very insightful is that we go into the details of what's going on in marketplaces is that we can uncover some new relationships and I think that this is going to be important work that we need to explore a little bit more from the trend following area. But we'll save that for another call,
- [64:38]
B
we'll save that for another day. I mean it's always so fun to be having these conversations with you because you never quite know what going to be in the next conversation. So really appreciate that. And of course you write a lot about many different interesting topics on your own blog, so people should definitely go and check that out as well. Now if those of you listening today want to just show some appreciation for Mark and all the work and preparation that he does, along with all the other co host, head over to your favorite podcast platform, leave a rating and review because it really does help more people people discover the the podcast and of course if you want to share it you can use a link called toptraders unplugged.com share and people should be able to sign up there. Next week I'll be joined by Allan. So that's going to be super interesting. I know he's up to some new stuff so I'm sure he'll going to mention some of that and if there are some questions For Alan Info Optraders Unblocked.com is the the email to use now. Of course there are lots of other things that we have on on the Top Traders website so people should go and check that out. Weekly monthly trend following reports, updates, blog posts, all sorts of interesting stuff. Even if I say so myself from Mark and me, thanks ever so much for listening and we look forward to being back with you next week. And until next time as usual, take care of yourself and take care of each other.
- [66:12]
A
Thanks for listening to Top Trad Unplugged. If you feel you learned something of value from today's episode, the best way to stay updated is to go on over to your favorite podcast platform and follow the show so that you'll be sure to get all the new episodes as they're released. We have some amazing guests lined up for you and to ensure our show continues to grow, please leave us an honest rating and review. It only takes a minute and it's the best way to show us you love the podcast. We'll see you next time on Top Traders Unplugged. This podcast expresses the views of its hosts and the guests appearing on the podcast as of the date of its recording, and such views are subject to change without notice. Top Traders Unplugged do not have any duty or obligation to update the information contained herein. Furthermore, Top Traders Unplugged make no representation to its accuracy and it shall not be assumed that past investment performance is an indication of future results. Moreover, wherever there is a potential for profit, there is also the possibility of loss. This content is made available for educational purposes only and should should not be used for any other purpose. The information contained in this podcast does not constitute and should not be construed as investment advice or an offer to sell or a solicitation to buy any securities or related financial instruments in any jurisdiction. Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third party sources. Top Traders Unplugged may believe that the sources from which such information are obtained are reliable. However, Top Traders Unplugged cannot guarantee the accuracy of such information and has has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. This podcast, including the information contained herein, may not be reproduced, copied, republished or posted in whole or in part in any form, without the prior written consent of Top Traders Unplugged.